As its name suggests, a cafeteria plan is a type of employee benefit pursuant to Section 125 of the Internal Revenue Code which allows an employee to choose where his or her benefit dollars will be spent. The plan can provide a number of selections, including medical, accident, disability, vision, dental and group term life insurance. It can reimburse actual medical expenses. It can pay children’s day care expenses. And, it does these things with pre-tax dollars. One thing to remember is that these benefits must be funded with tomorrow’s earnings, not yesterday’s. By that I mean, each person must estimate the costs that he or she will incur during the plan’s upcoming year and request to have the estimated amount redirected from wages into the plan.

Reasons for Implementing a Section 125 Plan:

• Primarily for the tax savings advantages for the employer and employee. Both parties save on taxes and therefore increase their spendable income.
• Employers save on the employer portion of FICA, FUTA and Worker’s Compensation premiums.
• Because these benefits are free from federal and state income taxes, an employee's taxable income is reduced, which increases the percentage of their take-home pay.

Benefits under a Section 125 Plan:

• Pre-tax health insurance premium deductions, also known as a Premium Only Plan (POP). POP plans allow employees to elect to withhold a portion of their pre-tax salary to pay for their premium contribution for most employer-sponsored health and welfare benefit plans. The plan offers a simple way to obtain favorable tax treatment for benefits already offered. Most companies currently have this set up through their payroll provider. A POP plan is the simplest type of Section 125 plan and requires little maintenance once it's been set up through your payroll.

• Out-of-pocket unreimbursed medical expenses, also known as flexible spending accounts (FSAs). An FSA allows an employee to fund certain medical expenses on a pre-taxed basis through salary reduction to pay for out-of-pocket expenses that aren't covered by insurance (for example, annual deductibles, office co-payments, prescriptions, over-the-counter drugs and orthodontia). The average working employee in America spends more than $1,000 annually on these types of benefits. By participating in a FSA, an employee's taxable income is reduced, which increases the percentage of pay they take home.

• Dependent care flexible spending accounts. The dependent care FSA is an attractive benefit for employees who pay for child-care or long-term care for their parents. Many employees don't take advantage of this benefit and may be unaware of the significant tax savings. Employees may hold back as much as $5,000 annually of their pre-tax salary for dependent care expenses, which include expenses they pay while they work, look for work or attend school full time. Qualified dependent care expenses may include--but are not limited to--the care of a child under the age of 13, long-term care for parents, care for a disabled spouse or a dependent incapable of caring for himself, and summer day camps. In addition, by paying for dependent care with pre-tax dollars, your employees can save approximately 20 to 40 percent on their child-care expenses.